Supreme Court Punts Issue of the Constitutionality of a Wealth Tax
What was supposed to be a major decision on economic policy ended up interesting only people with exotic foreign investments and their tax lawyers.
Does Congress have the power to tax citizens on their ownership of corporate shares that appreciate without being sold? In Moore v. United States, the Ninth Circuit said that the answer is yes, announcing that realization of income “is not a constitutional requirement” for Congress’s exercise of its power to tax “incomes” without apportionment among the states (which is the constitutional requirement for direct taxes on property).
The case arose when Charles and Kathleen Moore, who 20 years ago invested $40,000 in a friend’s start-up to supply agricultural equipment to rural farmers in India, were assessed a one-time “deemed repatriation tax” under the 2017 Tax Cuts and Jobs Act. If that assessment is sustained, it would potentially open the door to an Elizabeth Warren-style federal wealth tax and otherwise represent a serious expansion of Congress’s taxing power. It would also stand at odds with the original meaning of the Sixteenth Amendment—which enabled the federal income tax—and a long line of U.S. Supreme Court precedents holding that realization is necessary for a taxpayer to have taxable “income.”
After the Ninth Circuit ruled against the Moores, they successfully petitioned the Supreme Court to take the case (which petition I supported with an amicus brief on behalf of the Manhattan Institute). MI then filed an amicus brief on the merits, joined by originalist professors Erik Jensen and James W. Ely. We argued that the Framers intended the Apportionment Clause to be a hard limit on the central government’s taxing powers; the drafters of the Sixteenth Amendment intended a narrow definition of “incomes” as traditionally understood; and thus, the Mandatory Repatriation Tax is unconstitutional. In this case, to be argued late this fall, the Court should preserve the free enterprise that a constitutionally limited federal government facilitates.
Well, today the Supreme Court issued its decision, affirming the Ninth Circuit but not in the sweeping manner that court ruled. Instead, a seven-justice majority led by Justice Brett Kavanaugh (and joined in the judgment only by Justices Amy Coney Barrett and Samuel Alito) ruled for the IRS based on longstanding precedents establishing that, when dealing with an entity’s undistributed income, Congress may either tax the entity or its shareholders/partners. The majority noted that its decision is “narrow and limited to entities treated as pass-throughs,” warning that “nothing in this opinion should be read to authorize any hypothetical congressional effort to tax both an entity and its shareholders or partners on the same undistributed income realized by the entity.” “Nor does this decision attempt to resolve the parties’ disagreement over whether realization is a constitutional requirement for an income tax.”
Justice Clarence Thomas, joined by Justice Neil Gorsuch, dissented, emphasizing that the Court upholds the tax at issue “only by ignoring the question presented,” and instead answers a different question: “whether Congress may attribute an entity’s realized and undistributed income to the entity’s shareholders or partners, and then tax the shareholders or partners on their portions of that income.” He’s essentially saying that the majority disingenuously avoided that key question about the necessity of realization for income to be taxed. And I think he’s right.
While an unfortunate outcome, I can’t emphasize enough that this ruling is, in its own words, “narrow,” only applying to shareholders of corporations or other entities that tax law treats as “pass-throughs.” And again note that the majority disclaims (1) any authorization of Congress to tax both an entity and its shareholders on the same undistributed income, and (2) any resolution of the realization question. So those who hoped for a green light on a wealth tax—a tax either on accumulated wealth or on unrealized capital/other gains—and those (myself included) who wanted the Court to slam that door shut will both be disappointed. But at the end of the day it doesn’t mean much for anyone not affected by a somewhat obscure tax on foreign profits.
Win some and lose some. This sounds narrow enough that it affects the least number of people possible, which is a good thing. I guess they want Congress to try it and then hear it again. It's probably because there's been so many ridiculous Constitutional cases thrown at them since "the resistance" decided to use the law to gain or keep power that they feel the need to tread a bit lightly at the moment. I'm sure you'll get another go at it if Biden wins. Keep your notes, haha.